As governments and economies around the world struggle with the pandemic, green bonds are being increasingly touted as a way to help.

Just this week the European Union announced a €225B issuance, which will make up about 30% of the EU’s total rescue package. This amount is roughly equal to the total amount of all green securities sold last year, which should make the EU the largest issuer of green bonds.

EU Commission President Ursula von der Leyden says, ““I will ensure that it also takes green financing to the next level. We are world leaders in green finance and the largest issuer of green bonds worldwide.”

Banks, countries, and corporations around the world are increasingly using green bonds to raise money for investments with positive environmental impact.

But what exactly is a green bond?

Bonds are fixed-income securities that pay a set interest rate over the term of the bond. They are a way for governments and corporations to borrow money from investors in exchange for predictable, fixed payments over the term of the bond.

Green bonds, also known as climate bonds, are simply bonds where the money is explicitly set aside for investments in green projects. The International Capital Market Association has laid out its Green Bond Principles, and the Climate Bonds Initiative offers the world’s first certification program for green bonds. Nevertheless, there is still no universally recognized standard for what constitutes a green bond.

That said, green bonds are still a new category of security, and there is still some debate about what exactly qualifies as a green bond and who can issue them. For example, can a major polluter be a legitimate issuer of a green bond, even if all the money raised is truly going to carbon reduction initiatives?

Right now green bonds only represent about 1% of total bonds being issued, but the category continues to get more interest and coverage as extreme weather events attributed to climate change recur and governments around the world look at ways to bolster and stimulate their economic recoveries.

What do green bonds fund?

So where does the money go?

This is the most important question, because the answer determines whether the bond is green or arguably just another bond.

The World Banks’s most recent report on the impact of their green bonds gives a good overview of where green bond funding is going and the types of environmental impacts they’re trying to achieve.

Renewable energy & energy efficiency

This is one of the most common ways to invest money raised from green bonds. Since every company and government is also an energy consumer, energy-related investments are among the most broadly applicable uses for these type of bonds.

Building solar power plants, improving power grid efficiency, and similar efforts that ultimately reduce the carbon footprint and environmental impact of energy production and transmission are routinely cited as reasons why companies or governments are selling green bonds.

Transportation

23% percent of all energy-related greenhouse gas emissions come from the transportation sector. Making transportation greener generates a huge environmental impact.

So it follows that much of the money raised from green bonds is targeting this area. Typically that means investing in electrical vehicle and battery technologies that can reduce and replace our reliance on fossil fuels for transportation.

Forests & landscapes

As energy and transportation investments comprise about two-thirds of green bond funding, you might not think about trees being another use of these funds. But they are a big one as well.

Among their many environmental benefits, trees and plants are useful tools for carbon sequestration. Planting and growing them literally takes carbon out of the atmosphere.

So it follows that many companies in particular pursue their net zero goals by investing in tree planting projects that reduce their overall carbon footprint. And one popular way of funding these projects is of course green bonds.

Criticisms of green bonds

Despite their growing popularity, there are a number of criticisms and concerns about green bonds.

One is the lack of standardization or agreement on what counts as a green bond. What projects qualify, how much of an impact do they need to have, and who can issue them?

For example, the energy company Repsol was refused green bond certification from the Climate Bonds Initiative. Even though the bond would have funded carbon reductions for the company’s oil and gas operations, it was determined that the company’s overall sustainability strategy didn’t go far enough for them to qualify for certification.

Another criticism is that green bonds aren’t distinct enough from regular bonds. They don’t offer significantly different returns and often are funding projects that would be done anyway with regular bonds.

So what’s the use of them? This criticism sees green bonds as simply window dressing, while others would respond that regardless green bonds themselves are a way for investors and issuers to signal their environmental commitments.

While recognizing that green bonds do provide benefits and are useful, a recent article in The Economist found that they don’t appear to actually reduce carbon emissions.

The future of green bonds

While skepticism remains and some see green bonds as a passing fad, they continue to grow and garner news coverage.

The pandemic and the extraordinary economic rescue and stimulus that governments around the world are enacting are providing an opportunity for green bonds to play an increasing larger role in finance.

This paper proposes a set of recommendations for improving green bonds and making them effective as more than a communication tool or way of signaling green credentials. Standardization, reporting transparency, distinguishing green bonds more specifically from other sustainability-linked investments, and promoting mechanisms that better direct investments in emerging economies are key ways to make these bonds truly green and environmentally impactful.